Prop C’s Impact on San Francisco Rents

Jamie Mahoney of Transwestern discusses the potential effects of the newly adopted Proposition C on the city's office market, following the June elections. While many fear rent hikes, there are other factors to be considered.

In June, San Franciscans took to the polls to vote in statewide primary elections and on a number of new initiatives. Among them were two propositions with potentially far-reaching impact on the city’s commercial real estate. Both measures stood to increase taxes on commercial buildings in the city, already one of the world’s most expensive office markets.

The first, Proposition C, would levy a 3.5 percent tax increase on office properties and a 1 percent increase on industrial buildings within city limits. Most of the new tax revenue would be earmarked for child care and early education, seen as a critical need by proponents of the initiative. The measure required a simple majority to pass.

A competing measure, Proposition D, outlined a smaller increase on commercial real estate taxes. The earnings would be used to boost affordable housing within San Francisco. Due to the chronic shortage of affordable units, more and more city dwellers are moving further out from the city to reduce costs.

Prop C won the approval of a slim majority, securing 50.9 percent of the 236,000 votes cast. Prop D failed by a wider margin, with more than 55 percent of voters against it. One of the last major referenda to affect commercial real estate in the city’s history was Proposition M in 1986, which limits office development in the city to 950,000 square feet per year.

Jamie Mahoney, research analyst with Transwestern’s San Francisco office, discusses the impacts of Prop C on the city’s office market.

With Proposition C narrowly receiving a majority of the vote, what are the most immediate impacts landlords and tenants can expect to feel in San Francisco?

Mahoney: The most immediate impact would be an increase to asking rates for available office space. Tenants should expect to see an average increase of $2.57 per square foot for any space leased 2019 or later. This could increase the amount of sublease space to the market as tenants look to do more with less.

How can upcoming initiatives push back against the effects of Prop C?

Mahoney: There won’t be much pushback on Prop C since available space is becoming sparse within the city. Should the Central SoMa Plan be adopted, there may be some relief in the market, but Prop M will still limit any new supply from proposed office projects coming into the construction pipeline.

Given that office rents have been steadily climbing in San Francisco for some time, what do you anticipate the impact of the tax increase will be on office demand in the city?

Mahoney: Demand in the city is primarily coming from tech companies that seem to be strategically positioning for future needs. In essence, any negative effects of the tax increase likely will not deter major tech tenants from continuing to grow in downtown. However, traditional office tenants will likely see this as another reason to seek expansion of their real estate footprint in other markets or leave San Francisco entirely.

Will the impact be greater on certain types of businesses? Are there any exclusions or exceptions to the increase?

Mahoney: Office users are the primary target for Prop C. However, general warehouse users will also see a 1 percent increase. Residential, retail, nonprofits, arts and some industrial uses are excluded from the new tax.

What are the potential positive impacts of this measure on San Francisco commercial real estate?

Mahoney: One benefit could be an artificial compression on the market keeping it from overheating in the current cycle, but the positive impact is not likely going to be noticed as much as other factors such as Prop M.